The rising costs of college make saving for higher education particularly crucial. Over the past decade, university tuition fees have escalated significantly. Indeed, data from U.S. News & World Report shows that a four-year public college or university can charge over $100,000 in tuition and fees for out-of-state students. And the tuition and fees alone for a private university in the 2021-2022 academic year reached a stunning $240,000.
So how can the average parent prepare? Start saving for your child’s education as early as possible. One popular pathway chosen by many parents is a 529 plan – a tax-advantageous investment policy designed to save money for future tuition fees and it offers benefits such as tax-free growth of funds. Although these plans vary from state to state, their ability to allow your money compound tax-free is definitely appealing.
Now, what exactly are Section 529 savings plans? Named after their corresponding Internal Revenue Service (IRS) code, Section 529 plans have gained recognition as superior choices for building up a college fund. Two types of 529 plans exist: savings accounts and prepaid tuition plans. This write-up focuses mainly on the former.
The Section 529 savings account permits after-tax contributions to be made for a named beneficiary (not necessarily a child), which are then permitted to grow tax-deferred and can potentially be withdrawn tax-free for suitable educational expenses.
Getting a 529 plan not only aids your child’s studies but also treats you to some tax perks. Originally created for university-level education, 529 plans can now be used for K-12 education costs as well.
To kick-start this process, first review your state’s plan. All 50 states and the District of Columbia offer one or more 529 plans, and you aren’t confined to your home-state’s plan. However, if you’re entitled to tax reductions or credits in your state, it is definitely worthy of being considered.
Bear in mind that some benefits span multiple states. Seven states, in particular, offer tax reductions irrespective of which state’s plan you decide to invest in: Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana, and Pennsylvania. It’s also important to check on the return on investment and costs related to your chosen plan, not just the tax benefits. Higher net returns can be gained by minimizing costs.
Rates vary largely between direct plans, which are sold directly to account owners, and advisor-sold plans, which are distributed by brokers and financial advisors. You’ll save quite a bit if you’re adept at making your own investment decisions by opting for a direct plan.
Generally, 529 plans come in two primary forms: savings plans and prepaid tuition plans. The latter is currently available in fewer than ten states. These prepaid schemes allow locking in future tuition fees at current prices, but they typically restrict the choice of schools and cannot be used K-12 education. Always read full details and any restrictions.
Once you’ve chosen a plan, you’ll need to decide how to allocate your contributions. Most plans offer a variety of mutual funds, from conservative to aggressive. Some also provide other investment options like guaranteed investment contracts (GICs) from insurance companies and certificates of deposit (CDs) from banks. Diversification among several investments is also possible.
The earlier you start investing, the more beneficial it will be. Some plans offer automatic investment programs that withdraw your designated amount from your bank account on a regular basis and invest it in the plan. Investing gradually throughout the year, rather than in a lump sum, makes dollar-cost averaging possible.
Remember, the earlier you start with any savings plan, the better. Don’t delay and start researching today. Most parents start studying tax-advantaged 529 plans just after their first child is born. Despite the myriad of options and rules associated with 529 plans, don’t let the complexity deter you. The internet is your friendly resource, and if needed, consult a financial planner.
